Startup Advisory
Term Sheets in Indian Startup Funding: Key Terms Every Founder Must Understand
Lekha Editorial Team
CA-reviewed · Published
A term sheet is a non-binding document that summarises the economics and governance of a funding round. It looks simple. The financial implications of some clauses are not simple. A founder who signs a term sheet without understanding liquidation preference has routinely walked away from an exit with far less than they expected.
The Economics Clauses: Where the Money Actually Goes
Pre-money valuation and investment amount: the pre-money valuation is the company's agreed value before the investor's capital goes in. The post-money valuation is pre-money plus the investment. The investor's ownership percentage is investment / post-money. Simple.
Liquidation preference: this clause determines who gets paid first and how much in an exit (sale, merger, or liquidation). A 1x non-participating preference means the investor gets 1x their investment back before founders see anything, but they don't also participate in remaining proceeds — they choose between their preference and conversion to equity. This is standard and founder-friendly.
Participating preference (the bad one): the investor gets 1x back first AND participates in the remaining proceeds pro-rata to their ownership. This is economically equivalent to the investor owning more than their stated percentage of the company in an exit. At a 2x participating preference, an investor who owns 20% effectively captures 40% of the first pool (2x) and then 20% of the remaining — dramatically reducing founder economics in moderate exits.
A founder who agrees to participating preference at seed is giving away significant exit economics. Always negotiate to non-participating, and if the investor insists on participating preference, ask for a cap (the investor stops participating once they've received 3x their investment).
Governance Clauses: Who Controls What
Board composition: term sheets specify board seats. A typical seed-stage board has 3 members: 2 founders and 1 investor. At Series A, 5 members is standard: 2 founders, 2 investors, and 1 independent director mutually agreed by founders and investors. Losing board control (investors holding a majority of board seats) is almost always a risk indicator — avoid it at seed.
Protective provisions: these are matters that require investor approval regardless of their percentage ownership. Standard protective provisions cover: raising new capital, selling the company, changing the business's nature, amending the SHA, taking on debt above a threshold, and changes to founder compensation. Aggressive protective provisions extend to hiring/firing the CEO, every expenditure above ₹5 lakh, and entering any new contract above ₹10 lakh — these give investors operational veto power that should be resisted.
Information rights: investors typically receive quarterly financial statements, annual audited accounts, and an annual business plan. Major investors (typically Series A+) receive monthly MIS. These are reasonable and you should comply with them anyway as good governance.
Founder Protection Clauses
Anti-dilution provisions: protect investors in down rounds. Broad-based weighted average is the market standard — resist full ratchet. The difference matters significantly: in a down round, a BBWA provision adjusts the investor's conversion price moderately; a full ratchet adjustment gives the investor the new lower price entirely, sometimes reducing the founder's stake dramatically.
Drag-along rights: allow a majority of shareholders (or a specified threshold) to compel all other shareholders to sell their shares in an acquisition. Drag-along is standard, but the threshold and conditions matter. A drag-along that can be triggered by investors holding only 30% of the company, without board approval, gives investors excessive leverage.
Right of first refusal (ROFR): investors typically have the right to purchase their pro-rata share (and sometimes more) in any future round. This is pro-investor and slightly anti-founder because it makes it harder to run a competitive process on later rounds. Acceptable at seed; worth negotiating scope at Series A.
Founder lock-in: investors may require founders to stay with the company for 1–3 years post-investment. This is reasonable in spirit — investors are investing in the founders as much as the business — but the terms matter. What constitutes a 'departure' and what the consequences are (accelerated vesting? Board removal?) should be clearly defined.
Key takeaway
The most dangerous thing in a term sheet is the clause you don't notice. Read every provision. Model the economics in a spreadsheet for at least three exit scenarios (2x, 5x, 10x the round valuation). The participating preference that seems irrelevant at a 10x exit becomes very relevant at the 2.5x exit that's far more common in practice.
Frequently asked questions
Is a term sheet legally binding in India?
Most term sheets are explicitly non-binding, with two exceptions: the exclusivity clause (which prevents you from negotiating with other investors for a specified period, typically 30–60 days) and the confidentiality clause. The economic and governance terms become legally binding only when documented in the Shareholders Agreement (SHA) and Subscription Agreement. However, walking away from a signed term sheet without cause damages your reputation in the investor community, even if there are no legal consequences.
What is the difference between CCPS and equity shares in an Indian funding round?
CCPS (Compulsorily Convertible Preference Shares) are the most common investment instrument in Indian VC rounds. They behave like preference shares during the company's private life (giving investors priority in liquidation and dividend) and convert to equity shares at a triggering event (typically a qualifying IPO). From a FEMA (foreign investment) perspective, CCPS is treated as equity, enabling automatic route FDI. From an investor perspective, CCPS provides downside protection through the liquidation preference while maintaining equity upside.
What is a typical valuation for a seed-stage startup in India?
Seed-stage startup valuations in India in 2024 range widely by sector and traction. Consumer tech and SaaS startups with demonstrable traction (₹10–30 lakh MRR or 5,000+ active users) are typically valued at ₹8–20 crore pre-money. Pre-revenue startups with strong teams and clear problem-market fit typically command ₹3–8 crore. The 2020–2021 vintage saw significantly inflated valuations (2–5x these ranges); 2023–2024 returned to more fundamental-driven pricing.
What is a 'no shop' clause in a term sheet?
A 'no shop' or exclusivity clause requires the startup to stop actively soliciting other investors for a defined period (typically 30–60 days) after signing the term sheet. During this period, the investor conducts legal due diligence and prepares final documentation. Breaking the exclusivity clause while it's binding damages your reputation, even if the legal consequences are limited. Some term sheets include a 'break-up fee' — a cash payment if the startup accepts another investor's offer during exclusivity.
Can a founder negotiate the term sheet solo or should they hire a lawyer?
On significant rounds (above ₹1 crore), engage a startup-experienced lawyer to review and redact the term sheet before signing. The annual cost of the legal advice (₹30,000–₹1 lakh for term sheet review) is small against the economic impact of a participation clause or uncapped anti-dilution. Many first-time founders are too intimidated to push back on terms they've agreed to understand — a good lawyer gives you the analysis and language to negotiate effectively without damaging the relationship.